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Interest rates are a powerful tool and they’re on a collision course with the red hot US housing market.
A year ago, Americans could get 2.9% 30-year fixed mortgages; they’re currently at 5.1%. That has the market betting that housing will cool off dramatically.
Here’s the chart of XHB, the home builders’ ETF. It’s down about 27% from January 1 leaving many home builders trading at 4-5x earnings. There’s a clear message that the market expects home buying and investment to drop off. There’s been a similar drop in lumber mill prices despite continued high lumber prices — an indication that the market thinks it’s unsustainable.
Last week, I wrote about the largest home builder (D.R. Horton) and its positive outlook. If housing construction and prices can remain strong, it will be a strong tailwind for the US economy and commodity prices going forward. It will also leave consumers with more confidence and Americans historically haven’t been afraid to tap home equity loans.
Many more US home builders have now reported earnings. Here’s what they’re seeing (comments from executives on the conference calls):
Pulte (3rd largest home builder)
“As we sit here today, the bigger challenge by far isn’t getting houses sold, but rather getting them built.”
“The demand that we saw in the first quarter was exceptionally strong, and that’s continued into April.”
“I think it’s fair to say that the supply/demand dynamics of the first quarter were consistent with the trends the industry has been experiencing for the past year or more. In short, demand was strong, available inventory was scarce and the incoming supply is limited.
The company reaffirmed its guidance and said it’s holding back sales.
“With our production cycles remaining extended, we continue to tightly control sales in most of our communities across the country. We appreciate these restrictions can be frustrating for consumers but it is the right strategic decisions given overall conditions. From both the customer experience and a business risk perspective, it doesn’t make sense to extend our backlog out a year or more just to record another sign up.”
They also noted that gross margins were up 220 bps compared to a year ago despite cost inflation .
Taylor Morrison (5th largest builder)
“The positive sales momentum has continued thus far into April, and our sales teams across the country continue to report that activity overall remains resilient. However, we should expect that the recent rise in mortgage rates could begin to impact the consumer, particularly in communities focused on the most affordable segment of entry-level buyers, which are only a small minority of our portfolio.”
The company said that average credit scores of borrowers are among an all-time high and down payments of 24% are higher than a year ago despite larger loan amounts.
“I would like to share a few notable takeaways from our consumer surveys, which included feedback from over 1,500 home shoppers in the first quarter. First, in response to how higher mortgage rates would impact their home surge, only a single-digit percentage of all respond and said they would stop their home search if affordability became a constraint, instead opting to modify their plans either by reducing [indiscernible] increasing their down payment or slowing down their search. This is quite different from what surveys indicated as rates increased in 2018 when shoppers were twice as likely to say they would stop their home search at that time, suggesting current demand is much more determined to move ahead.”
Meritage Homes (6th largest builder)
The company lifted its earnings guidance by 13-14% but also had this to say.
“We recognize that the recent surge in interest rates and 6 quarters of strong pricing power will eventually impact buyers psychology and affordability.”
That was balanced by this: “In addition to early month sellouts from January to April, our cancellation rate of 9.6% this quarter is similar to the last 8 quarters and low compared to our historical levels and what is typically expected for entry-level products…. In April, our demand remains healthy and steady even as rates continue rising.”
“Although we continue selling homes fairly quickly, we recognize current dynamics are not sustainable indefinitely. And eventually, homebuilding demand will stabilize. We welcome the market stability, which we believe is necessary for sustainable long-term growth.
We can flex with market conditions and slow down our starts if there is any choppiness in the market demand and focus on smaller products for homes with fewer amenities.”
This is how they say customers are responding to rates:
“Someone who was thinking about or looking for a house in the 500 is now looking for a house in the 400. So we do see people shifting around that kind of those price bands based on interest rates going up and down.”
Looking ahead, they see little signs of an impact from higher rates:
“All the leading indicators around traffic and web activity, contact center activity, those are all very, very strong as well. They certainly come off of their peaks given the rise in rates, but still very, very strong flow of inbound interest in our homes”
Century Communities (9th largest builder)
“There’s been a little less traffic, but the amount of traffic that we are getting in the amount of demand that we’re seeing so far exceeds the supply of homes that we have available. I wouldn’t say there’s any particular markets or price points that’s different in terms of what we’re seeing in terms of interest level. But I think it’s something that historically we always see when you have interest rates go up. You really get 2 actions from buyers. It pulls some buyers off the fence because they want to go ahead and buy. And then the other thing it does is it keeps some people on the fence as they have to digest it. And be — get to a point where they say, okay, they’re comfortable with it.
“Really, in a lot of cases, a buyer is really making a choice for — to purchase much of our product on are they going to continue to rent or are they going to purchase a home? And rental rates certainly aren’t softening. So when you look at that trade-off of continuing rent or being able to lock in on a longer-term basis, which our housing costs are, it’s still very attractive even with these increased rates to buy a home.”
“We’re continuing to be able to sell our homes before they’re complete. And if we start seeing that changes in the market, then we’ll adjust how we market, sell and price our homes. But we’ve not reached that point yet,” they said.
M.D.C. Holdings (12th largest builder)
“Demand was broad based from both a geographic and pricing standpoint with the millennial age buyer continue to being the driving force behind our sales success. This large population of buyers has reached a prime phase in their lives when homeownership became a much higher priority… We believe that the demand forces we see today are long term in nature and will continue to support the new home market for the foreseeable future.”
“We have continued to see good traffic levels in our community since rates started rising a few months ago. Though we have noticed that the sales process is taking a little longer, most buyer seem to be adjusting to the higher rate environment as well and continue to be motivated to move forward with their purchase.”
Beazer Homes (17th largest builder)
“I really do believe that there is a structural gap between the supply and demand for housing. And so I am generally in alignment with what you said some of our peers have commented. I think that the volume opportunity for our industry for new homes is pretty stable. I feel good about that.How that plays out when we meet the affordability challenge? I don’t know.”
“There continues to be a structural gap between the demand for housing and the total supply of housing.”
“Considering demand, supply, and the mortgage market, we think the multiyear context for new home activity is pretty positive.Of course, against this reasonably optimistic backdrop, the obvious threat facing our industry is affordability. It doesn’t matter how much demand there is for housing if consumers can’t afford to pay a price that reflects the cost of production.”
Masco
Masco is an American manufacturer of products for the home improvement and new home construction markets. It generates 90% of its sales from the restoration and renovation market.
The company lifted its EPS guidance by 1%.
“We, as expected, are seeing some tempering of the, call it, white-hot demand we’ve seen in the last 18 months. We talked about that last quarter and while demand this quarter was a little bit better than we expected, there’s a little bit of tempering from what we’ve seen in the past 18 months. However, it’s still strong. We are not seeing really any sort of evidence. There’s a little bit of a mix shift, but nothing material.
“The consumer continues to be willing to spend as driven by the overall change in the view of the housing and the home, in our view, driven by COVID. And we’re seeing strong sales in our spas. That backlog of our spas, a very expensive discretionary item, but in the right spot as it relates to the whole wellness trend. And that backlog continues to be in that 30-week range. So that’s strong. Hansgrohe and our higher-end shower systems continue to sell well. We’re seeing our shower doors, which are relatively expensive, continue to sell well.
So no real mix down, strong traffic, good backlogs. And again, this all feeds into why we’ve decided to change our guide in the first quarter, which typically we don’t do because we like what we’re seeing and the strength of the consumer.”
Longer term, they outlined positive secular factors:
“We’re on the leading edge of a large 75 million millennial cohort forming households and entering the housing market. 2.7 million more homes will reach the prime remodeling ages of between 20 and 39 years old over the next 3 years.”